Inheritance tax is being paid by more and more people as its net sweeps ever wider, and this will only increase as changes announced last year by Rachel Reeves, the chancellor, take effect.
From April 2026 the amount that can be claimed under agricultural property relief and business property relief will be reduced, and from April 2027 most pension pots will be included in an estate for inheritance tax purposes.
Meanwhile, higher house prices and asset inflation are pushing more people over the £325,000 tax-free amount that everyone can pass on, and the additional £175,000 allowance available to those leaving a main home to a direct descendant, provided that their estate does not exceed £2 million.
A lot will depend on your circumstances and bespoke advice is always advisable, but I have been a lawyer for 20 years and work with clients every day to help them to protect and pass on their wealth and assets. There are some key things I would urge everyone who is thinking about estate planning to keep in mind.
Start early
The earlier you can start thinking about estate planning the better, and giving money and assets away to loved ones is often central to these plans. Inheritance tax is charged at 40 per cent on most assets but remember that anything left to a spouse or civil partner is tax-free, and they can also inherit each other’s tax-free allowances. This means that between them a couple can pass on £1 million. Pensions can also be left to a spouse inheritance tax-free, even after the rules change in 2027.
The earlier you can start thinking about estate planning the better
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Gifts made in your lifetime generally become exempt from inheritance tax if you live for seven years after making them. Taper relief applies to the rate of tax charged on gifts made within three and seven years of your death.
If, however, the value of a lifetime gift is lower than your £325,000 inheritance tax-free allowance (known as the nil-rate band) then the allowance is applied to that lifetime gift before it is applied to the rest of your estate and there will be no tax due on the gift itself and no tax to taper.
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If the value of the gift is higher than your available nil-rate band, then it will be taxed at 40 per cent if you died within three years; 32 per cent if you lived for three to four years after making the gift; 24 per cent if you lived four to five years; 16 per cent for five to six years; and 8 per cent if you lived six years. If inheritance tax is due on any lifetime gifts, the primary responsibility to pay that falls on the recipient, unless you have provided otherwise in your will.
Gifting earlier rather than later obviously increases the chances of surviving the seven-year rule, but there is a lot more to effective estate planning than gifting. Starting early gives the opportunity to really think about what you want to achieve and how best to structure your assets, as well as plan for death with a tax-efficient will.
It is also important not to treat estate planning as a one-time thing. Ideally, it should be an ongoing project that evolves over the years and can be updated as family dynamics, individual needs and legislation change.
Use trusts wisely
If structured and used correctly, trusts and family investment companies can help to reduce your inheritance tax while allowing you to retain some control of your assets.
Trusts are useful for lifetime gifting, but you can also nominate a trust to receive any death-in-service benefits from your employer or put a life insurance policy into trust. This could mean that the funds would be fully available to a spouse, if needed, but that the value would not inflate their estate for inheritance tax purposes.
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It is really important to take proper advice around setting up trusts because if they are structured incorrectly they can mean that you end up losing out on valuable reliefs and exemptions. We often have clients ask us about what are known as ”asset protection” trusts, but these often end up resulting in a higher inheritance tax liability.
Family investment companies are bespoke private firms created to hold investments for a family, which can be used as a tax-efficient alternative to family trusts. It is a flexible structure, allowing families to define how specific family members benefit through varying rights attached to shares, or the number of shares in issue. A family investment company may provide particularly useful protection in the event of a shareholder’s divorce.
You need cash sums of at least £1 million to bother with one, though, because of the set-up and ongoing administration costs.
Consider a deed of variation
This is an under-used but very inheritance tax-effective measure. It is a legal document that alters how a person’s estate is distributed after they die and allows someone who inherited from the estate to give away part or all of their share.
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This removes the inheritance from their own estate to avoid a future tax liability on their death, therefore deeds of variation are often used so that an inheritance skips a generation.
By using a deed of variation to transfer the inheritance, or part of it, into a discretionary trust, you can also continue to benefit from the funds you have inherited without the usual limitations imposed by reservation of benefit rules. These dictate that an asset is still considered to be part of your estate for inheritance tax purposes if you give it away but continue to benefit from it, such as if you give the family home to a child, but continue to live there rent-free until you die.
A deed of variation can mean an inheritance skips a generation
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Crucially, any deed of variation must be made within two years of the death and beneficiaries can only change their share of an inheritance, not anyone else’s.
Life insurance
Life insurance policies that will pay out to cover inheritance tax bills when you die are very useful planning tools, but you need to consider the amount of cover that will be required, and review your estate regularly to ensure that it will be enough.
If written into trust, the proceeds from these policies can be kept outside your estate. If not held in a trust your estate could lose 40 per cent of the payout to inheritance tax.
One reason why these policies are so useful is that they are often paid to the beneficiaries of the policy relatively soon after death, which can assist in paying the tax bill sooner rather than later. Given that inheritance tax is due six months after the date of death, and late payments accrue interest of 8 per cent, being able to ensure that the tax is paid within the deadline is useful.
Think like the taxman
Keep really accurate records of all gifts you make as part of your estate planning. One of the biggest sources of conflict between executors and HM Revenue & Customs is around record keeping — or lack of it.
We recommend keeping a detailed log including the date of the gift, the amount given or the value of the item gifted, the recipient and your relationship to them and whether the gift came from your capital or surplus income.
This is important for all types of gifts, but especially those made out of surplus income — a gifting loophole that allows gifts to be immediately exempt from inheritance tax. You must be able to show, however, that the money has come from income that you do not need, rather than capital such as savings or the proceeds of a house sale.
It is worth looking at HMRC’s form IHT403 to see the type of records that your executors will be expected to provide in relation to lifetime gifts.
The most common inheritance tax mistakes
• Thinking that there is such a thing as a common law spouse when it comes to inheritance tax — if you are not married or in a civil partnership you will not inherit each other’s assets tax-free
• Giving away too much early on and not leaving enough to fund your retirement and potential care needs later in life
• Making gifts without considering risks, such as the person who receives the gift getting divorced. Pre-nup and post-nup agreements should supplement lifetime gifting where appropriate
• Retaining benefit from a gift, for example by giving away a holiday home but continuing to use it — this would mean it would still be included in your estate for IHT purposes and could be subject to 40 per cent tax
Fiona Higgott is a partner at the Tunbridge Wells law firm Thomson Snell & Passmore